Buying the dip in the market has often made bundles for investors. The strategy worked beautifully in early 2016. If you bought then, you’ve probably made out like a bandit. The markets are off the highs seen in late 2017 and early this year. Time to load up again?
Maybe not. The smarter strategy may be to sell as the herd use the dip to load up one more time. There are several big indications that global growth has peaked and that a few big economies, such as Germany’s, are about to shift into reverse.
You might have no worries if you were to read the headline reports. Take the latest tranquilizer from the International Monetary Fund. On Tuesday, the IMF confirmed that global growth will hit its fastest pace in seven years in 2018, with a 3.9 per cent gain, and again in 2019. It expects the United States economy to expand at 2.9 per cent this year, up from its previous estimate of 2.7 per cent, while the euro zone should gain 2.4 per cent.
So what’s not to like?
Let’s start with oil. You may remember that about a year and a half ago, Saudi Arabia and Russia made a pact to cut OPEC and Russian production.
The deal worked. Oil inventories are falling and the price is going in the opposite direction. On Friday, Brent crude, the international benchmark, was trading at about US$73.50 a barrel, up 7 per cent since the start of the year and 38 per cent in the last 12 months.
Some analysts expect to see US$80 oil pretty soon, even though U.S. President Donald Trump on Friday used a tweet to blast OPEC for keeping prices “artificially Very High!” Saudi Arabia and Russia desperately need high oil prices to balance their budgets. The Saudis also need a high price to guarantee the success of the initial public offering of Saudi Aramco, the world’s biggest oil company and exporter.
Yes, the price is still half of its precrisis peak. But the more important measure is the recent gain. Oil has more than doubled since dipping to US$35 a barrel in early 2016. Energy costs are climbing everywhere. Note the costlier fill-ups and airline tickets eating into your disposable income. According to the U.S. Energy Information Agency, the average price of a gallon of gasoline in January, 2016, was US$2.05. Last month, it was US$2.70 – an increase of 32 per cent.
Economists will never agree on what exactly triggered the 2008 financial crisis and subsequent deep recessions, but most would agree that soaring oil prices played some role. Prices are now more or less at their 2006 levels. If they go much higher, households might cut back on spending to keep their cars and trucks rolling.
Another chart that is going in the wrong direction is Citibank’s Economic Surprise Index. Less obscure than you might think, the index is a measure, in effect, of misplaced optimism and pessimism. The index asks economists what they expect. If the various economic data come in stronger than the forecasts, the index rises; if they come in worse than expected, it falls.
Guess what? It’s falling everywhere. The Group of 10 Surprise Index is in negative territory, meaning the actual data numbers are coming in worse than forecast. The U.S. and European editions are falling precipitously. While the Surprise Index is far from a perfect indicator of performance, the deterioration among the three versions suggests the good times might be ending.
Take the euro zone in general and Germany in particular. In the euro zone, industrial production declined for three consecutive months, through February, for the fist time since 2012, when the exodus of Greece seemed imminent and Italy seemed on the verge of a sovereign bailout.
In Germany, investor confidence has stumbled to its lowest level since late 2012, partly because of fears of a global trade war, while Dusseldorf’s Macroeconomic Policy Institute this week put the chances of a German recession over the next three months at 32 per cent. The figure means a recession remains unlikely, but there is no doubt the shift in mood has been remarkably fast. In March, the institute put the chances of a German recession at less than 7 per cent.
There’s more. The fixed-income markets are giving hints that the end of the economic cycle is nigh. The best clue is the flattening of the U.S. yield curve, with the yield on two-year Treasuries at 2.43 per cent, their highest level since August, 2008, a month before Lehman Bros. collapsed. The gap between the two-year yield and the 10-year yield is less than half a percentage point, making the yield curve its flattest since 2007.
In itself, a flattening yield curve does not mean the end of the world. It could mean that investors are worried that the U.S. Federal Reserve is jacking up interest rates too fast, or it could indicate a slowing economy. If the yield curve were to invert – that is, if short-term yields become higher than long-term yields – all bets are off. Historically, an inverted curve has been a fairly reliable indicator of an imminent recession.
While investors should be wary that a few key indicators hint at a correction – or worse – don’t forget that Mr. Trump’s tax deal will see hundreds of billions of dollars of overseas cash repatriated. A lot of the loot will be put into share buybacks, pumping up shareholder returns. It may work, or not, or may work just for a short time. That top-of-the-cycle feeling is building.
Eric Reguly